Pandemic and global security shocks shake up supply and demand
Economists from leading trade credit insurer, Atradius, have published their predictions on the future of global value chains and warned against businesses making any major changes to their production strategy, despite ongoing challenges.
In the report, Atradius claims that the Covid-19 pandemic posed unprecedented challenges to global value chains. Demand and supply-side shocks created several bottlenecks, including logistical disruptions and shortages in equipment and labour. Atradius highlights the Russia-Ukraine conflict as a key factor for exacerbating already existing disruptions, distorting parts of the European value chain and rising commodity prices.
Production was hit in the early stages of the pandemic by factory shutdowns in China before moving to Europe and the US throughout 2020. Although this had an immediate effect on the global production of manufactured goods, Atradius suggests that the manufacturing industry quickly recovered to pre-pandemic levels and is now relatively resilient to new waves of infections.
On the demand side, Atradius reports that consumption patterns shifted from local services to imported manufactured goods, such as electronic products and equipment, partially due to the increase in people working from home. The demand for goods still remains and as such, has resulted in a sharper than usual downturn in equipment and material shortages relative to demand.
One major industry that is still struggling is the semiconductor industry. This is due to a rapid rebound in vehicle sales during lockdown and post-pandemic. And, despite being only partially integrated into the European supply chain, Atradius draws attention to the fact that Russia and Ukraine provide some key manufacturing inputs, particularly in the automotive industry. Similarly, labour shortages are also a key risk for industrial recovery in both the EU and the US.
Shipping costs also soared due to the misallocation of shipping containers, and several ports had problems processing cargo due to a shortage of dockworkers and truck drivers. Atradius suggests the situation has not significantly improved in recent months.
To counteract these growing challenges, Atradius explains that firms may be tempted to consider several options to improve supply chain resilience, including reshoring production, diversifying suppliers and customers, and holding more inventory. However, Atradius warns that alternatives such as these could come with important downsides and that they do not necessarily increase robustness or resilience.
In terms of reshoring, Atradius argues that localised production is no guarantee for robust value chains and that almost every economy is affected by both supply and demand shocks, despite their different degrees at different stages.
Diversification of suppliers at the various steps of production in a value chain can increase robustness and resilience. But Atradius warns that this can lead to additional costs for firms, as they need to invest in multiple suppliers to tailor inputs and to make sure that parts and components from different manufacturers fit together. In a similar vein, holding more inventory is likely to be the most straightforward way to enhance the robustness of global value chains, but this also comes at a cost.
Damien Dawson, regional manager at Atradius UK & Ireland, said: “Despite the Covid-19 pandemic and the Russia-Ukraine conflict posing a number of problems for global trade, we do not expect to see a major shift in production strategy nor any major step back on the globalisation ladder. Though alternative solutions to global value chains are tempting, they pose equally challenging risks and do not always offer a better solution.
“Instead, we think it is more likely that firms will make slight adjustments to their production strategies such as maintaining higher inventories of critical goods, such as medical supplies. There may be limited reshoring as labour costs in some manufacturing hubs, notably China, increase as they move up in the value chain, but this would have happened irrespective of the current supply chain bottlenecks. Our belief that the key economic rationale for global value chains continues to hold is substantiated by experience with previous supply chain shocks, such as during the 2008/2009 financial crisis and the 2011 Japan earthquake.”
For the full report https://atradius.co.uk.